Eyes wide open
A financial company based in Hong Kong recently unloaded all its holdings of Asian stocks. A company official said employees sold their shares to enjoy year-end holidays. But that may not be entirely true. The move came as the U.S. Federal Reserve is poised to raise interest rates for the first time in nearly a decade. “Nobody knows whether the rate hike will send a shockwave to the world economy or end up as a storm in a teacup,” he said.
The world is holding its breath. It is looking at a dark, looming cloud. International commodity prices are nose-diving. Capital is fast draining out of emerging economies. Stock markets in Asia and elsewhere fall collectively.
The symptoms all suggest danger. The world’s major economic engines are moving in opposite directions. The United States is starting to suck up the liquidity it has let loose over the past seven years. Other major economies - Japan, the European Union and China - go on pumping out liquidity. In the past, when the United States changed gears to tighten monetary conditions, the world economy had shown signs of overheating. This time, it’s different. The United States is performing a solo act and setting the stage for the Great Divergence of 2015.
What we are about to witness is entirely new. We cannot know the outcome. Emerging economies could be confused with the different directions taken by the big economies. When we are lost, we must look back on where we came from for clues. Today’s environment is similar to 1994, when the U.S. Fed swiftly changed its rate course upward. The U.S. economy was hit by a chain of insolvencies of savings and loan associations in the late 1980s. More than 900 financial institutions closed down by the early 1990s. The Fed brought down the benchmark interest rate to as low as 3 percent, a record low at the time. The real interest rate when factoring in inflation was close to zero, as it is now.
That loose monetary policy helped revive the economy by the early 1990s. The policy-making Federal Open Market Committee led by Alan Greenspan began to adjust the policy rate. In just a year, the Fed rate gained 3 percentage points. U.S. monetary policy hinges on inflation. But strangely, inflation was not a concern at the time. The Fed raised the interest rate to “normalize” its monetary policy.
The normalization policy of the Fed caused disasters elsewhere. Mexico fell apart due to an exodus of foreign funds. The domino effect reached Argentina and as far as Asia, hitting Korea in 1997. We ended up with a humiliating international bailout from the International Monetary Fund.
Money is much looser this time. The Fed brought down the policy rate to near zero percent in February 2008. When it had no further rate maneuvering left, it resorted to the unprecedented quantitative easing program. Over the last seven years, about $4 trillion has been unleashed. If that massive sum boomerangs back to the United States, the toll on emerging economies could be as devastating as in the 1990s.
Ominous signs can already be seen. The Institute of International Finance warned that emerging market stocks and currencies have reached “crisis proportions” with $33.8 billion exiting from investment portfolios in emerging markets. Korea is, of course, not the same as it was in the 1990s. Its economy fundamentals are much more solid now. Korea’s foreign exchange reserves reached $368.5 billion as of the end of November. Its short-term foreign debt totals a mere 30 percent of foreign reserves. The country maintained a sizable surplus in its current account for 44 months in a row until October. It cannot be compared with vulnerable emerging economies like those of Turkey, Argentina and Malaysia.
But we must not let our guard down. Companies are ailing. Last year’s combined sales of Korea Inc. fell for the first time since 2007. Commodity exports are expected to decline for the second consecutive year. Household debt hovers above 1,200 trillion won ($1.02 trillion). A time bomb is ticking. The National Assembly is ignoring bills that can retool and stimulate the economy, including those related to reforming the labor market. Deputy Prime Minister for the Economy Choi Kyung-hwan is counting his days in office with his mind entirely engrossed with the April 13 general election.
The Fed rate hike comes at a sensitive time. The U.S. economy appears to be on a path to recovery. Yet the Fed is raising rates when it should be doing more to stimulate the economy. We are stepping onto an entirely unfamiliar path.
We are too sanguine. We are taking a forewarned crisis for granted. We must not be overly anxious, but at the same time cannot afford to be complacent. How we tackle the new challenge is entirely up to us. The forewarned crisis could turn out to be a real crisis. We must keep our eyes wide open.
JoongAng Ilbo, Dec. 16, Page 32
*The author is head of the international economic team at the JoongAng Ilbo.
by Kim Jong-yoon